Steve Lonegan and the 'Laffer Curve'

On Aug. 28, 2006, two economists had a brief televised debate that has since become a YouTube classic.

One of them was Arthur Laffer, who is famous as the originator of what came to be known as the "Laffer Curve," which was popularized back in the Reagan administration. This is a graph that shows that when taxes rise above a certain rate, revenue begins to fall.

Laffer argued in that eight-minute debate that wealth had "risen dramatically" during the administration of George W. Bush.

"The U.S. economy has never been in better shape," Laffer said.

His debate opponent did not agree.

"It's not wealth that increased in the last few years," Peter Schiff replied. "All that's increased is the paper values of our stocks and real estate. When you see the stock market come down and the real estate bubble bursts, all that phony wealth is going to evaporate and all that's going to be left is all the debt we accumulated to foreigners."

At the time, that was considered a nutty notion among Republicans. And Schiff was considered a nut. But after that day last September when Lehmann Brothers went bankrupt and the whole scheme collapsed, Schiff looked like a genius.

The genius was in the Statehouse Tuesday giving a speech on behalf of Republican gubernatorial contender Steve Lonegan. I spent about a half-hour chatting with him afterward.

Schiff is a proponent of the so-called "Austrian School" of economics. That sounds exotic, but the Austrian school is not much different from the traditional American view of economics associated with the Old Right: Save as much as you can; borrow as little as you can.

Schiff's dispute with mainstream Republicans stems mainly from their misuse of the aforementioned Laffer Curve. When the curve was employed as it was in the Reagan era -- to get rid of a federal income-tax rate of 70 percent -- Laffer's idea made perfect economic sense.

Many people have since distorted the meaning of the Laffer Curve to argue that all tax cuts produce revenue gains. But Laffer didn't say that, because it's stupid. And he's not stupid.

A lot of the inside-the-Beltway Republicans aren't so bright, however. And by the time of the second Bush administration they were twisting Laffer's logic to argue that tax cuts were good all the time.

As for spending, it hardly mattered. Foreigners would lend us the money.

This was heresy to the Austrians, but it's a heresy that the mainstream GOP has yet to recant, Schiff said.

"There's going to have to be a change in which the Republicans say: 'We were to blame. Now we're different,'" he said.

Unfortunately they're not different, if the race for the Republican nomination for governor is any indication. Lonegan is proposing drastic cuts in government and a flat income tax. But the mainstream GOP is backing former U.S. attorney Chris Christie, a Bush appointee who follows in the Bush tradition of promising tax cuts without specifying commensurate spending cuts.

"The people who promise the tax cuts don't promise the budget cuts," Schiff said.

Schiff proposes such cuts, as does Lonegan, but it's not a popular view inside the GOP. Party leaders like to talk about cutting government when they're out of power, but once in power they like to hand out the patronage and the pork. The Austrians, meanwhile, really mean it when it comes to cuts.

Schiff is closely linked to another member of the Austrian School, Ron Paul, a Texas congressman who ran unsuccessfully in last year's GOP presidential primary. Like Schiff, Paul was pigeonholed as a nut last year when he blasted Bush's loose-money policies. And like Schiff, he got it right when the rest of the party was still getting it wrong.

As for Laffer, he's sounding a lot more like Schiff these days. Schiff chalks his old debating partner's prior mistakes up to a sort of temporary insanity.

"I just think he was a cheerleader for the Bush administration," said Schiff. "He didn't understand the problems with our economy. He didn't understand how cheap credit was encouraging reckless spending."

He understands it now. Recently Laffer has been emphasizing the need to return to fiscal fundamentals. And Laffer has also endorsed Lonegan. So even if Lonegan accomplishes nothing else, he has gotten the two former debating partners to agree on who should be running New Jersey.

As for who should be running the United States, that's another question.